The problem with QE2. Comstock Partners.
POMO still matters. Jim Bianco.
I wouldn't normally be this liberal in extensively excerpting from another author's post, but the IRA's weekly letter is only freely available for one week, after which time it goes behind a subscription firewall, and I thought this post worthwhile enough to have recorded:
Triple Down: Fannie, Freddie, and the Triumph of the Corporate State. Chris Whalen, IRA.
Despite examples of the success of restructuring with F and even General Motors, the invidious cowards who inhabit Washington are unwilling to restructure the largest banks and GSEs. The reluctance comes partly from what truths restructuring will reveal. As a result, these same large zombie banks and the U.S. economy will continue to shrink under the weight of bad debt, public and private. Remember that the Dodd-Frank legislation was not so much about financial reform as protecting the housing GSEs. Because President Barack Obama and the leaders of both political parties are unwilling to address the housing crisis and the wasting effects on the largest banks, there will be no growth and no net job creation in the U.S. for the next several years. And because the Obama White House is content to ignore the crisis facing millions of American homeowners, who are deep underwater and will eventually default on their loans, the efforts by the Fed to reflate the U.S. economy and particularly consumer spending will be futile. As Alan Meltzer noted to Tom Keene on Bloomberg Radio earlier this year: "This is not a monetary problem."
Indeed, the public embrace by the Federal Open Market Committee of further quantitative easing or "QE", instead of calling for the immediate restructuring of the largest zombie banks, actually threatens to push the U.S. into a deeper and far more dangerous economic path. According to the Q2 2010 Bank Stress Index survey conducted by IRA and our review of the Q3 2010 earnings results, the financial condition of smaller lenders is actually improving. While the FDIC now has over 800 banks on its troubled list, the righteous banks for which we currently have "positive" outlooks in The IRA Advisory Service are showing better earnings and less credit stress.
Part of the reason for the improvement is that the FDIC and state regulators have taken a very hard line with smaller banks, pushing many into resolutions and distressed asset sales. But for the healthy lenders that survive and investors that buy failed banks, there will be a lot of money left on the table -- profits that will come back into earnings via recoveries and other windfalls and help to boost the private economy. Resolution and liquidation is how a free market economy regenerates. The trouble is, the approach taken with the large banks and the GSEs is precisely the opposite of that applied to smaller lenders. The policy of the Fed and Treasury with respect to the large banks is state socialism writ large, without even the pretense of a greater public good.
Forget Treasury Secretary Tim Geithner lying about the relatively small losses at American International Group (AIG); the fraud and obfuscation now underway in Washinton to protect the TBTF banks and GSEs totals into the trillions of dollars and rises to the level of treason. And the sad part is that all of the temporizing and excuses by the Fed and the White House will be for naught. The zombie banks and GSEs alike will muddle along until the operational cost of servicing bad loans engulfs them. Then they will be bailed out -- again -- or restructured....
So why did our BSI measure show rising stress in Q2 2010? Over the past several years, the large zombie banks actually looked better on our BSI survey than the average, this due to overt subsidies, QE and low interest rates. But now the larger lenders are sinking under the weight of rising servicing costs, falling asset returns and other problems linked to mortgage securitizations. So while the Fed continues to try to revive the largest banks via massive monetary ease, the FOMC is at the same time preparing to do further damage to solvent lenders, insurers and other investors via QE2.
The IRA has spoken to a number of executives in banks and life insurance companies about the impact of QE and Fed zero interest rate policy on their income statements and balance sheets. The universal message: If rates do not return to "normal" levels by year-end, the pain in terms of reduced earnings on assets and the resultant negative cash flow will start to become so apparent that the financial markets will actually notice. In particular, we have been told that by year end several of the largest publicly traded banks and life insurers could show significant declines in net interest earnings due to QE -- declines driven by falling net interest income that may provoke ratings downgrades. And when this next systemic crisis comes -- whether in December or later in 2011 --- the full blame will belong to the members of the Bernanke Fed and the Obama Administration.....
Walter Bagehot believed that central banks should lend aggressively in times of financial insolvency, the rate of the loans should be very high -- not zero as is the current FOMC policy. John Hussman wrote: "Bagehot's name has surfaced in a few editorials in recent weeks, but they have invariably focused on the "lend freely" portion of his advice, while overlooking Bagehot's admonition to impose costs, capital requirements, and other safeguards where public funds are concerned. In short, liquidity should be available to Fannie Mae and Freddie Mac, but the interest rates charged should be very high."
Of course the problem of adopting Bagehot's rule regarding high real credit costs is that you immediately expose all of the insolvent financial institutions -- including the US Treasury. This the Obama Administration, Treasury Secretary Geithner and the functionaries on the FOMC will not do. But the examples of Ford, GM and the smaller banks in the U.S., most of which have restructured without bankruptcy, suggest that the path to economic renewal requires reorganization and losses to creditors.
In the case of the large banks and GSEs, this means a great deal of pain for investors and taxpayers alike when, no, if, these institutions are finally restructured. But that is the good news and thereby lies the path to national recovery. What we need from the Fed is some leadership on the issue of making the White House take responsibility for restructuring the economy.
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